Agency Problems in Target-Date Funds

Target-Date Funds (TDFs) are popular retirement investment vehicles that follow a predetermined schedule for rebalancing their mix of equity and fixed-income securities over time. We explore potential agency problems in TDFs by examining their return performance and their flow-performance relation. We find that TDFs under-perform balanced funds (BFs) which are also approved as a default option along with TDFs in 401(k) plans. We show that the under-performance is driven by TDFs that have a fund-of-fund structure which invests in funds with high expense ratios and low performance within the fund family. Additionally, we discover an absence of flow-performance relation in TDFs while BFs exhibit the convex flow-performance relation documented for mutual funds. Our evidence suggests the presence of agency problems in TDFs arising from investor inertia, weak incentives for fund managers to outperform peers, and opportunities for fund families to gain private benefits